Mergers and Acquisitions in Cyberspace
Navigating the Black Holes
Vol. 6
January 2006
Page
Introduction
The development of the Internet has dramatically reshaped the merger and acquisition ("M&A") landscape from both a business and legal standpoint. Much of the M&A activity over the past few years has involved companies that either operate exclusively in cyberspace or that rely on e-commerce as an important component of their business activities. In a number of cases, companies actively acquired the assets of failed dot-com businesses. More recently, acquirers, in many cases public companies, have targeted Internet companies that weathered and survived the downturn.
As with other new technologies, the development of the Internet has resulted in legal refinements in a variety of areas as the law struggles to catch up with the technology. While some laws and judicial decisions make no distinction between companies engaging in cyberspace activities and traditional bricks-and-mortar businesses, many other areas remain in a state of evolution because of new Internet-based business models. The expansion of the Internet and the corresponding legal developments have forced M&A practitioners to familiarize themselves with a number of new legal issues for transactions involving companies engaged in e-commerce activities.
As a result, M&A attorneys need to fully appreciate and understand Internet-related issues in order to properly advise and obtain adequate protection for their clients. There are several areas of concern for businesses acquiring companies with substantial cyberspace activities, such as taxation of e-commerce activities, which previously have received extensive focus from commentators.[1] Rather than revisit those issues, this article focuses on five different legal "black holes" on which there is little written guidance and/or the law is continuing to rapidly evolve. Specifically, this article addresses (i) securities law issues; (ii) intellectual property issues; (iii) restrictive covenants; (iv) employment law issues; and (v) foreign qualification issues, each in the context of acquiring a business engaged in ongoing cyberspace business activities.[2]
Securities Law Issues
A huge area of potential liability for Internet-based companies involves the prior issuance of securities. Because start-ups typically have limited financial resources, they often rely on stock options or warrants as vehicles to attract, retain, and reward initial employees and consultants. Employees like to receive incentive stock options because of the huge upside that can result from a business that rapidly increases in value and subsequently enjoys an exit event, whether it is an acquisition or an initial public offering ("IPO"). In many cases, however, companies establish the underlying equity incentive plans or issue securities without appropriate consultation with securities law counsel.
Perhaps the most noteworthy example of a company that failed to properly comply with state and federal securities laws is Google, Inc. While preparing for its IPO in 2004, Google disclosed in a filing with the Securities and Exchange Commission (the "SEC") that it failed to comply with federal and state blue-sky laws (in close to 20 states) in connection with the issuance of approximately 23 million shares of stock and 5.6 million stock options to over 1,000 current and former employees and consultants.[3] Securities regulators were concerned that Google distributed the options to employees as part of their compensation without providing adequate financial information about the company. Google conducted a rescission offering with respect to all of the improperly issued securities in which the company offered to buy back the affected shares and outstanding options for approximately $26 million. So as to not to delay or jeopardize its IPO, the company subsequently entered into a settlement with the SEC and state regulators in which Google agreed to cease and desist from committing or violating any provision of the securities laws.[4]
M&A practitioners involved in an acquisition of an Internet-based business-especially where the transaction is structured as a merger or a stock purchase-should focus during the due diligence process on the target company's adoption of equity incentive plans and the issuance of prior securities. Attorneys should pay particular attention to incentive stock options and warrants as well as any attempts by the target company to offer to sell securities over the Internet.
In addition to performing appropriate due diligence, acquirers should insist on representations and warranties in the acquisition agreement covering compliance with (i) state blue-sky and federal securities laws; and (ii) corporate requirements associated with the offering and issuance of the securities or adoption of plans, including preemptive rights and anti-dilution protections.[5] In addition, because the prior termination of employees who were granted options often can lead to claims following an exit event,[6] an acquirer may want to consider specific representations and warranties or special indemnification provisions with regard to such matters.[7] Finally, it may be appropriate for an acquirer to require the target company to conduct a rescission offering with regard to improper prior issuances of securities if significant issues are discovered during due diligence.[8]
Intellectual Property Issues
Another area where start-ups operating in cyberspace often take shortcuts that later can become significant issues in the acquisition process, if not outright deal-killers, relates to title and protection of intellectual property.
Obviously, a significant portion of the value of any Internet company resides in the intellectual property of the business, including the Web sites it owns or operates. Accordingly, acquirers must have a good understanding of all of the company's intellectual property rights and the potential liabilities associated with such assets.
To do so, acquirers and their attorneys must spend a significant portion of their due diligence validating the intellectual property from both the business and legal perspectives.[9] Standard due diligence checklists typically are written in such broad terms to pick up the relevant intellectual property assets and contracts. With the creation of new types of Internet-related agreements, licenses, and intellectual property assets, however, it is advisable for acquirers' attorneys to specifically tailor their due diligence checklists so as to better focus attention on the types of agreements[10] and other items[11] that the target company should disclose. In addition, as part of due diligence, acquirers should ensure that no liens or encumbrances exist on any of intellectual property rights. A standard Uniform Commercial Code ("UCC") search typically is only the starting point with regard to such intellectual property rights.
Along with conducting a proper due diligence inquiry, an acquirer should obtain representations and warranties in the acquisition agreement that:
· The target company has all right, title, and interest to the intellectual property it uses in its business activities.
· No intellectual property being acquired infringes on the intellectual property rights of any other party.
· All e-commerce activities and Web sites are operated and maintained in accordance with appropriate commercial practices and all laws and regulations.
Ownership or proper licensing of the underlying intellectual property is critical for a cyberspace company. As a result, the representations and warranties in the acquisition agreement should provide that (i) the target company owns or properly licenses all intellectual property; (ii) the target company can validly transfer all intellectual property rights; and (iii) no undisclosed party has retained any rights to any intellectual property being acquired. In some cases (particularly in the early stages for start-ups), the company may have allowed parties to web development agreements to retain certain rights to the "look and feel" or content of a Web site, which can create problems for an acquirer.[12]
With regard to infringement, in addition to obtaining a general and broad representation that no intellectual property being acquired infringes on the rights of any other party, the representations should provide that the target company has not received notice of any possible infringement actions, whether under the Digital Millennium Copyright Act or otherwise.[13] Acquirers also should consider whether their own technology, when combined with the target company's technology post-closing, may infringe on any other party's intellectual property rights.
The use of domain names has spawned a number of infringement lawsuits as well as administrative actions before the World Intellectual Property Organization and other organizations charged with dispute resolution by the Internet Corporation for the Assigned Names and Numbers ("ICANN") under its Uniform Domain-Name Dispute Resolution Policy. The use of a particular domain name by a company can result in liability claims under the Anti-Cybersquatting Consumer Protection Act,[14] the Lanham Act,[15] state law, or common-law trademark and service mark principles. Similarly, the use of a "meta-tag" (an embedded file that while not readily visible can be read and indexed by Internet search engines) within a Web site can infringe on the common-law or registered trademark or service mark rights of a third party.[16]
Depending on the specific nature of the company's Web sites, acquirers also should consider obtaining specific representations to provide additional liability protection with regard to possible infringement actions that: (i) the domain names for the target company's Web sites are not trademarks or service marks of any other companies; (ii) the target company has the right to link to other Web sites to which its Web sites are linked;[17] (iii) the target company has the appropriate rights to display all names, symbols, logos, trademarks and other intellectual property of any party that is located on its Web sites and does not display any trade secrets of any other party thereon; (iv) the target company's Web sites do not use meta-tags that infringe upon any other business's trademarks, service marks or other intellectual property rights; and (v) there are no actions pending before an ICANN-sanctioned arbitrator or otherwise.
Finally, acquirers should obtain specific representations and warranties with regard to compliance with customary commercial practices and applicable laws and regulations.[18] Acquirers should request warranties that all Web sites have appropriate protections in place to prevent unauthorized modification or alteration by third parties. To confirm its due diligence findings, acquirers may also require express representations and warranties as to the traffic on the relevant Web sites. As part of due diligence, acquirers may want to consider having an independent third party or tracking software verify a company's data, so as to ensure that the company does not artificially inflate the number of unique visitors or hits through their own visits to the Web site. In drafting and negotiating such contractual provisions, attorneys also should ensure that the measurement provisions are drafted precisely in order to obtain the most relevant information and confirm the underlying valuation metrics.[19]
Restrictive Covenant Issues
Following the company's IP rights, oftentimes the next most valuable intangible asset of an Internet-based business consists of the restrictive covenants or other agreements that the company's employees have executed. In many cases, these individuals are critical to the success of the Internet business venture and represent important intellectual capital.[20] The ongoing battle between the industry giants Microsoft and Google this year, over an employee's noncompetition covenant, perhaps best highlights the significance of these issues for high-tech companies.[21]
As part of the due diligence process, an acquirer should request copies of all confidentiality, nondisclosure, invention assignment agreements, and restrictive covenants (e.g., noncompetition and nonsolicitation covenants) executed by the company's employees and independent contractors. Oftentimes, these provisions appear in employment agreements of senior executives of the company. Attorneys for the acquirer then must determine (i) whether the acquirer likely will continue to enjoy the benefits of the agreements following the acquisition; and (ii) if so, whether the agreements likely will be enforceable under applicable state law.[22]
The enforceability of the noncompetion and nonsolicitation covenants used by companies to protect their investment in employees is a matter of state law, and while a few jurisdictions completely prohibit employee noncompetition covenants,[23] most states enforce agreements imposing reasonable restrictions on employees.[24] Although noncompetition law can vary dramatically among jurisdictions, generally for an employee noncompetition covenant to be enforceable, it must contain reasonable geographic and time limitations and be reasonably limited in the scope of prohibited activity.[25] Whether a nonsolicitation covenant constitutes a noncompetition covenant that must satisfy the same requirements also varies by state.[26]
As a result of the unique state law issues regarding employee restrictive covenants and their assignability, there is no guarantee that an acquirer still may enforce such agreements following an acquisition, particularly one structured as an asset purchase. Some jurisdictions provide that a company can never assign noncompetition covenants.[27] Other states permit an employer's successors or assigns to enforce noncompetition covenants so long as the original employment contract contains an express assignment clause.[28] Still other jurisdictions follow a rule that, absent a contrary provision in the agreement, a noncompetition covenant may be freely assigned and enforced by an assignee.[29]
In reviewing restrictive covenants to determine the likelihood of enforceability, M&A practitioners should realize that the traditional rules of interpretation might not apply to companies operating in cyberspace. Because of the rapidly changing nature of the technology and the ability of the Internet to reach any jurisdiction from any location, courts have shown a willingness to apply different rules to cyberspace employees with regard to the geographic, time, and prohibited activity limitations.
Recently, courts have been cognizant of the global reach of the Internet in construing geographic restrictions in employee noncompetition covenants.[30] While no published opinion has yet gone so far as to eliminate completely the geographic requirement for cyberspace companies as a matter of law, arguably the Internet has made geography irrelevant.[31] Similarly, with regard to time restrictions contained in cyberspace employee covenants, courts have suggested the acceptable period restriction is shorter because of the rapid speed at which the business of Internet-based companies and technologies change.[32] The fact that information loses its competitive value more quickly for cyberspace companies means that, at least in this instance, time does move more quickly in the Internet age. Finally, in reviewing limitations on prohibited activities in high-tech cases, courts have shown an inclination to ensure that these restrictions are consistent with, and limited to, the job previously performed by the employee.[33]
Nonsolicitation covenants also raise unique issues for cyberspace companies. To be enforceable, these clauses probably cannot prohibit solicitation of all customers, as often is the case with traditional businesses, because such a restriction presumably would apply to anyone who could access a company's Web sites. Cyberspace companies, however, still can restrict the ability of employees to directly solicit parties with whom the company has established business relationships and other employees of the company.
In reviewing restrictive covenants, attorneys for acquirers should review carefully each of the geographic, time, and activity restrictions in light of the company's current business as well as the proposed business of the acquirer. In addition, attorneys should determine whether the relevant agreements contain acknowledgements that (i) the company conducts Internet-based business activities; (ii) consumers are able to access the company's Web sites from any geographic location; (iii) the monetary barriers to establishing and engaging in a competitive business over the Internet are relatively small; and (iv) the geographic, time, and restricted activity limitations contained in the restrictive covenant are reasonable, given the foregoing considerations.
If an acquirer expects to obtain the benefit of restrictive covenants, confidentiality agreements, or similar agreements through assignment in an asset acquisition, the acquisition documents should specifically identify and assign these items.[34] To the extent an acquirer has concerns about the enforceability of the restrictive covenants, either due to assignment issues related to the structure of the deal, as a result of the manner in which the original covenants were drafted, or because of the relevant state's attitude towards these covenants, oftentimes the better approach for an acquirer is to ensure that the underlying parties to the relevant agreements expressly consent to their assignment or enter into new legally enforceable agreements with the acquirer.
Aside from employee restrictive covenants, M&A practitioners typically must deal with the negotiations related to new restrictive covenants from equity owners as part of the acquisition. In addition to the issues discussed above for employees, attorneys need to realize that at this point it is unclear whether courts will interpret the geographic and time restriction requirements for former equity owners of cyberspace companies more broadly in the "sale of business" context than in the "employment" area. This has been the typical approach for courts in cases involving non-Internet companies because of the different policy considerations involved in acquisitions and the employee-employer relationship. The logic behind the cyberspace employee cases discussed above, and recognition of the "dynamic nature" of the Internet, however, may apply with equal force in the sale of business arena.[35]
To provide additional protection from equity owners who are not being retained after the closing, acquirers should include a nondisclosure covenant with regard to all confidential and proprietary information being acquired as part of the acquisition as well as a nonsolicitation covenant. By placing the separate nondisclosure and nonsolicitation covenants in the acquisition agreement itself, an acquirer may increase the likelihood of enforceability by preventing a court from confusing these provisions with a noncompetition covenant, which is typically contained in the separately executed agreement.
In many cases, however, the former equity owners of the target company will continue to act as employees or consultants for the acquirer following the closing because they are a critical component of the value of the acquired cyberspace business. In addition to the documents executed as part of the consideration for the acquisition at the closing, acquirers should take the same precautions they take with their other employees and have such parties execute the acquirer's standard-form confidentiality, nondisclosure, nonsolicitation, and noncompetition agreements.
Employment Law Issues
As noted above, acquirers of cyberspace companies frequently wish to maintain relationships with the target company's employees, including its former equity owners, as well as its independent contractors. As a result, it is important for M&A practitioners to focus on liability issues that can arise with respect to such parties both in due diligence and the acquisition agreement.
A number of Internet start-ups attempt to avoid paying overtime, payroll taxes, workers' compensation insurance, and other benefits by hiring independent contractors instead of employees. Under the Fair Labor Standards Act and the Internal Revenue Service guidelines, only if parties truly are independent (e.g., exercise control over their own work) do they qualify as independent contractors.[36] As a result, substantial exposure for wages and employment taxes can exist to the extent a company has improperly classified individuals as independent contractors, whether deliberately or inadvertently.
Another area where Internet ventures particularly are prone to significant financial and legal exposure relates to overtime laws. The expectation at many start-ups is that employees will work long hours to get the business off the ground. In addition to the incentive stock options described above, these companies often pay salaries to all of their employees to avoid paying any overtime for the long hours put in by employees. In most cases, however, the business never investigates whether these employees are in fact exempt from overtime requirements in the first instance.
M&A practitioners need to review carefully the relevant statutes and underlying regulations issued by the Department of Labor ("DOL"), particularly for computer-related occupations in evaluating whether employees of cyberspace companies are exempt from overtime requirements. Under these regulations, while many computer programmers may not be exempt from the overtime requirements, some software designers may be exempt.[37]
Incorrect classification of a group of employees can lead to a subsequent action (particularly after the announcement of an exit event) on behalf of all similarly situated employees by disgruntled former employees, the DOL, or analogous state regulatory agencies. As such, in addition to specific representations and warranties regarding compliance with overtime laws, acquirers may desire to obtain special indemnification in the acquisition agreement for such potential liabilities, which can include substantial penalties such as the doubling of damages to aggrieved employees.
Cyberspace companies also have a higher risk profile for sexual harassment and inappropriate blogging claims.[38] The combination of relaxed dress policies, relative youthful age of the workforce, more informal work atmosphere, and long work hours often combine to create a work environment more susceptible to questionable behavior.[39] Inappropriate, careless, or offensive communications contained in blogs or emails can also create liability for a company.
Blogs raise significant concerns for acquirers of Internet-based companies. Employees working at Internet-based and start-up companies fit the demographic for the typical blogger.[40] While individuals generally discuss politics and interests on blogs, they also can delve into their work environment, coworkers, and bosses. As such, bloggers can inadvertently cause their employers and acquirers significant legal hardship. For example, a blogger could (i) disclose confidential information and trade secrets;[41] (ii) engage in gun-jumping or trigger other securities law violations; (iii) post copyrighted music or other items on their blog during company hours; (iv) engage in sexually or other harassing behavior;[42] or (v) harm their company's business reputation by complaining about company policies or the work environment.[43] As part of the due diligence inquiry, acquirers therefore should request copies of the company's policies regarding (i) blogging, (ii) e-mail retention and destruction, (iii) e-mail and web usage, and (iv) e-mail monitoring.
Foreign Qualification Issues
A final and often overlooked area of potential liability for cyberspace companies relates to foreign qualification. When a company engages in business outside of the state in which it is incorporated or organized, it may be required to obtain a "foreign qualification" from the other jurisdictions in which it operates.[44] Whether a company must qualify in a foreign jurisdiction depends on whether it is "doing business" in that jurisdiction under the applicable foreign qualification statutes, as that state's courts or regulatory agencies have interpreted such statutory provisions.
As most M&A practitioners realize, determining whether a traditional business with no Internet presence has received all necessary foreign qualifications is often difficult because it involves a facts-and-circumstances analysis of the activities the company engages in and requires a review of different laws in various jurisdictions. Obviously, the foreign qualification issue is more difficult when analyzing cyberspace companies due to the evolving questions regarding jurisdiction and local governmental authority over Internet activities.[45]
Failing to obtain foreign qualifications can be significant in some jurisdictions.[46] This issue arises if an acquisition is structured as (i) a merger or stock transaction, where the acquirer can have liability based on the target company's prior operation of the business; or (ii) as an asset purchase, where the acquirer can have exposure for its own operation of the business after the acquisition. In the latter case, attorneys for acquirers need to determine whether, because of an acquisition, their client now needs to qualify to do business in a foreign jurisdiction where it previously was not required to be qualified.[47] The implications of a foreign qualification on future business activities can also be significant as a party may subject itself unintentionally to jurisdiction for tax or other purposes.[48] Because of these foregoing considerations, M&A practitioners should focus carefully on this issue in transactions involving companies with Internet activities.
Another area of foreign qualification potential liability involves companies that use ".com" as part of their corporate name. Before the proliferation of domain names endings other than ".com," it was quite common for companies to register a domain name to enjoy the cachet of being a "Dot-com Company." For companies that chose such a name, many issues can exist due to foreign qualification statutory provisions.
Most foreign qualification statutes contain a provision that requires a company's corporate name either to be "not deceptively similar to" or "distinguishable on the records of the secretary of state from" other businesses already established as a domestic entity or qualified as a foreign business entity in such state.[49] For example, regulatory authorities in some states may take the position that merely adding ".com" (or for that matter ".org" or ".net") to the end of the corporate name "ACME" is not sufficiently different to permit foreign qualification under the name "ACME.com, Inc." where an "ACME, LLC" or "ACME, Inc." already exists in the jurisdiction.[50] Correspondingly, even if "ACME.com, Inc." is able to obtain a foreign qualification under its official corporate name, there may be no prohibition under the jurisdiction's statutes to prevent an "ACME, LLC" or "ACME, Inc." from subsequently being organized or qualifying as a foreign corporation in the state.
Finally, M&A practitioners should be aware of the foregoing foreign qualification issues in rendering third-party legal opinions on behalf of a client with substantial cyberspace activities. Such third-party legal opinions are often a condition to closing for acquisitions.[51] In many cases, M&A practitioners are requested to opine that their clients are duly qualified in all states in which the nature of their client's business makes such qualification necessary. Based on the discussion above, attorneys representing cyberspace companies should consider carefully the type of opinion they are prepared to give on the status of their client's foreign qualification.[52]
Conclusion
Acquisitions of companies engaged in substantial e-commerce activities are more complex than other transactions because of the start-up nature of these ventures and their penchant for being early adopters of new technologies. To be effective in this area, M&A practitioners need to understand the unique issues and latest legal developments as they affect cyberspace companies. By understanding the difficult "black holes" that exist with regard to cyberspace companies, attorneys can either steer their clients away from trouble or at least use traditional tools - whether specific representations and warranties, elimination of knowledge and materiality qualifiers, carve-outs from baskets or caps, special indemnification provisions, or earn-out provisions - to navigate through these issues and obtain adequate deal and liability protection for their clients.[53]
[1] See generally Nathaniel T. Trelease & Lea Anne Sotrum, The Gathering Storm: State Sales and Use Taxation of Electronic Commerce, 30 Corp. Tax'n 16 (2003); Arthur J. Cockfield, Balancing National Interests in the Taxation of Electronic Commerce Business Profits, 74 Tul. L. Rev. 133 (1999); Val John Christensen, Leveling the Playing Field: A Business Perspective on Taxing E-Commerce, 2000 BYU L. Rev. 139.
[2] See generally Roland L. Trope & Gregory E. Upchurch, Checkpoints in Cyberspace: Best Practices to Avert Liability in Cross-Border Transactions (forthcoming Feb. 2006).
[3] Google, Inc, Form S-1 Registration Statement Under the Securities Act of 1933 (Aug. 4, 2004), available at link [hereinafter Google Filing].
[4] In re Google, Inc. & David C. Drummond, Securities Act Release No. 33-8523, Admin. Proc. File No. 3-11795 (Jan. 13, 2005), available at link.
[5] See 17 C.F.R. § 230.701 (2004) (contains Federal Rule 701 regarding stock options). See generally Howard M. Friedman, Securities Regulation in Cyberspace (3d ed. 2005).
[6] The practice of granting incentive stock options to employees in lieu of a higher base salary or bonus can create potential liability in the context of an exit event. Employees who are terminated prior to the vesting of their incentive stock options are more likely to bring a wrongful termination lawsuit when the company has undergone rapid growth and the options are worth a significant amount as a result of the exit event. See Scully v. US WATS, Inc., 238 F.3d 497 (3d Cir. 2001) (holding that a telecommunication carrier breached an oral agreement with its president when it fired him without cause and denied him the opportunity to exercise his stock options).
[7] Acquirers may want to consider a specific representation and warranty that a target company has no reason to believe any such claims exist, including any notice of such claims, as well as provisions in the indemnification section providing for carve-outs for such claims from any baskets or caps. See generally Lou R. Kling & Eileen Nugent, Negotiated Acquisitions of Companies, Subsidiaries and Divisions (1992); Bus. L. Sec., Am. Bar Ass'n, Model Asset Purchase Agreement with Commentary (2001) [hereinafter Model APA Agreement]; Bus. L. Sec., Am. Bar Ass'n, Model Stock Purchase Agreement with Commentary (1995) [hereinafter Model SPA Agreement].
[8] A recission offering is not without risk, as parties may elect to reject the recission offer and instead sue the issuer for securities law violations. See, e.g., Google Filing, supra note 3.
[9] David E. Swarts, Buying a Dot-com, 10 Apr. Bus. L. Today 16, 19 (2001), available at link. While the Internet has created new issues for M&A practitioners performing due diligence, it also has made due diligence on cyberspace companies easier in certain respects. Because the Web sites of a cyberspace company frequently include information about the company as well as its operations and business partners, these Web sites can provide useful information to the lawyers performing due diligence and allow for more focused requests and inquiry.
[10] For example, attorneys for acquirers should add the following agreements to their due diligence checklists: (i) Web marketing, co-branding licensing and advertising agreements; (ii) Web-linking or framing agreements with other Web sites; (iii) Web hosting agreements; (iv) Web development and design agreements; (v) Web content creation, licensing and access agreements; (vi) affiliate, strategic alliance, and joint venture agreements; (vii) placement agreements with search engines, (viii) software development and license agreements; (ix) maintenance agreements and warranties for servers; (x) source code escrow agreements; and (xi) any electronic contracts. Id. at 18; see also Gary M. Lawrence & Carl Baranowski, Representing High Tech Companies §§ 6-1 to 6-62 (1999).
[11] In addition to the normal requests for all intellectual property (including any trademarks, service marks, copyrights, trade names, etc.), attorneys for acquirers of cyberspace companies should request the following information: (i) a list of all Web sites and domain names, or applications or reservations for either; (ii) all current and prior privacy policies, terms and conditions of use and disclaimers posted on any Web sites to be acquired; (iii) descriptions of Internet firewalls; (iv) description of policies and procedures to monitor other e-commerce companies' use of the target company's intellectual property; and (v) copies of reports documenting traffic on all relevant Web sites. Swarts, supra note 9, at 19.
[12] To the extent that a cyberspace company has used consultants or independent contractors (as opposed to employees) to create intellectual property, acquirers should ensure that any work product created by such persons contractually has been treated as "work-for-hire" or otherwise properly assigned to the company. Generally, an employee is obligated to assign patent rights to an employer (i) if there is an express provision in the contract requiring such assignment; (ii) the employee was specifically hired to invent; or (iii) the employee is an officer of the corporation with the fiduciary obligation to act in good faith and in a manner reasonably related to the best interests of the corporation and its shareholders. See, e.g., Lacy v. Rotating Prods. Sys., Inc., 961 P.2d 1144 (Colo. Ct. App. 1998). If, however, the employment relationship does not entail one of these three factors, then an employee is under no obligation to assign the patent to his employer although the employee probably will have to grant his employer "shop rights" or a free and non-exclusive right to practice the patent if the employee used company resources to invent the patent. See, e.g., Scott Sys., Inc. v. Scott, 996 P.2d 775 (Colo. Ct. App. 2000).
[14] Anticybersquatting Consumer Protection Act, 15 U.S.C. § 1129 (1999). The Anti-Cybersquatting Consumer Protection Act makes it illegal for a person to "register, traffic in, or use" a domain name of another person if the domain name is a trademark (or confusingly similar to the trademark) of another person, and the person who registers, traffics in, or uses the domain name has a "bad faith intent to profit" from that trademark. Id.
[16] See Playboy Enters., Inc. v. Calvin Designer Label, 985 F. Supp. 1220 (N.D. Cal. 1997) (determining that the hidden use of the words "Playboy" and "Playmate" constituted trademark infringement).
[17] Similarly, if information is framed from other Web sites, a company should have approval from the party whose information is being framed. See generally Cyberspace Law Committee, Bus. L. Sec., Am. Bar Ass'n, Web Linking Agreements: Contracting Strategies and Model Provisions 24-25 (1997) (hereafter Web Linking Agreements).
[18] Depending on where a company does business, state-specific laws may apply. See, e.g., Cal. Bus. & Prof. Code § 17538 (2004) (requiring retail companies that accept orders from California residents to comply with certain provisions); S.B. 1386, 2002 Cal. Stat. 915 (amending Cal. Civ. Code §§ 1798.82, 1798.29) (protects California consumers by requiring businesses to disclose to California' consumers any breaches in computer security that could compromise their personal information).
[19] The appropriate method of traffic measurement for a Web site may be described in a number of ways, such as "eyeball return rate," "unique visitors," or "hits." See generally Web Linking Agreements, supra note 17. An "eyeball return rate" measures the number of times a Web page is requested, while "unique visitors" refer to all unique e-mail addresses that visit a Web page. On the other hand, a "hit" technically refers to a single request for a file. Requesting a single page may involve calling up several different files, which would register several hits for a single visit, which may or may not be the relevant measurement of traffic. Differences in the tracking criteria can substantially affect the underlying value methodology. Swarts, supra note 9, at 19.
[20] See Katherine J. Clayton, Liquidating a Technology Company in Bankruptcy, 4 N.C. J. L. & Tech. 169, 179 (2002); Lois R. Lupica, The Technology Rich "Dot-Com" in Bankruptcy: The Debtor as Owner of Intellectual Property, 53 Me. L. Rev. 361, 381 (2001).
[21] Microsoft v. Lee, No. 05-2-23561-6 SEA (Wash. Super. Ct. Sept. 13, 2005); Allison Linn, Microsoft, Google Reach Settlement, Rocky Mountain News (December 23, 2005), available at link
[22] While M&A practitioners should check all agreements to determine whether the proposed structure of the acquisition will trigger notice or consent requirements under assignment or "change in control" provisions as in any due diligence review, it is particularly important to review these provisions in the employee-related agreements for cyberspace companies. See generally Model APA Agreement, supra note 7, at 64-67; see generally Annotation, Enforceability, By Purchaser of Successor of Business, of Covenant Not to Compete Entered into By Predecessor and Its Employees, 12 A.L.R. 5th 847 (1993).
[24] In many states, noncompetition covenants are expressly permitted for the protection of trade secrets. See, e.g., Colo. Rev. Stat. § 8-2-113(2) (2004). In addition, many states authorize such covenants for executive and management personnel and officers, which in some cases do not apply to independent contractors. Id.; see also Smith v. Sellers, 747 P.2d 15 (Colo. Ct. App. 1990).
[25] In some jurisdictions that allow reasonable noncompetition agreements, court strike down the entire covenant if one provision is overbroad. Other courts will "blue pencil" a covenant and enforce the reasonable restrictions while invalidating the overly broad provisions. See, e.g., DoubleClick, Inc. v. Henderson, No. 116914/97, 1997 WL 731413 (N.Y. Sup. Ct. Nov. 7, 1997) (reducing time limitation under New York law from one year to six months).
[26] Courts have split on whether nondisclosure and nonsolicitation covenants must contain geographic and time restrictions. See Lawrence & Baranowski, supra note 10, at §§ 3-12 to 3-13; Atmel Corp. v. Vitesse Semiconductor Corp., 30 P.3d 789 (Colo. Ct. App. 2001) (finding that nonsolicitation covenants must satisfy provisions applicable to noncompetition covenants).
[27] See, e.g., Reynolds & Reynolds v. Hardee, 932 F. Supp. 149 (E.D. Va. 1996), aff'd, 133 F.3d 916 (4th Cir. 1997) (noncompetition covenants never are assignable when contained in employment agreement).
[28] See Hess v. Gebhard & Co. Inc., 808 A.2d 912, 921 (Pa. 2002); Saliterman v. Finney, 361 N.W.2d 175 (Minn. Ct. App. 1985). In All Pak, Inc. v. Johnston, 694 A.2d 347, 351 (Pa. Sup. Ct. 1997), the court noted that "[g]iven that restrictive covenants have been held to impose a restraint on an employee's right to earn a livelihood, they should be construed narrowly; and absent an explicit assignability provision, courts should be hesitant to read one into the contract."
[29] See, e.g., Special Products Mfg., Inc. v. Douglass, 553 N.Y.S.2d 506 (N.Y. App. Div. 1990) (holding that a restrictive covenant was enforceable by a successor because noncompetition covenants are freely assignable unless defeated by a clear and unambiguous contractual prohibition); Gill v. Poe & Brown of Georgia, Inc., 524 S.E.2d 328 (Ga. Ct. App. 1999) (nonsolicitation agreement could be assigned by employer to company, without employee's consent because the non-solicitation agreement did not prohibit unilateral assignments).
[30] See Nat'l Bus. Servs., Inc. v. Wright, 2 F. Supp. 2d 701, 708 (E.D. Pa. 1998) (enforcing restriction under Pennsylvania law and noting that "[t]ransactions involving the Internet, unlike traditional sales territory cases, are not limited by state boundaries"); Intelus Corp. v. Barton, 7 F. Supp. 2d 635 (D. Md. 1998) (upholding restriction under Maryland law with no geographic restriction for computer software company and product specialist).
[31] By its very nature, the Internet contains no geographic boundaries and a company can set up a Web site that may be accessed from anywhere in the world. Some courts in the future may take the position that to satisfy the geographic restriction, a noncompetition covenant for an employee of a company that operates solely over the Internet only may prohibit a party from Internet activities (i.e., the covenant expressly should allow the restricted party to operate a competitive traditional bricks-and-mortar business). In such a case, a number of areas would remain in which the restricted party could compete in the same general business as the Internet company, just not through the same medium.
[32] See EarthWeb, Inc. v. Schlack, 71 F. Supp. 2d 299, 316 (S.D.N.Y. 1999), aff'd in part, 205 F.3d 1322 (2d Cir. 2000) (refusing to enforce a one-year noncompetition covenant under New York law because "[w]hen measured against the IT industry in the Internet environment, a one-year hiatus from the workforce is several generations, if not an eternity."); see also DoubleClick, Inc. v. Henderson, No. 116914/97, 1997 WL 731413 (N.Y. Sup. Ct. Nov. 7, 1997) (reducing time limitation under New York law from one year to six months).
[33] See Marshall v. Gore, 506 So.2d 91 (1987) (holding under Florida law that the scope of a noncompetition restriction for an employee that developed software for feeding cows was overly broad to the extent it applied to software development generally).
[34] Compare McGladrey & Pullen, LLP v. Shrader, 62 Va. Cir. 401 (Va. Cir. Ct. 2003) (because asset purchase agreement specifically assigned the employment contracts but made no mention of confidentiality and non-solicitation agreements, the assignee could not enforce these agreements) with Chemetall GMBH v. ZR Energy, Inc., 320 F.3d 714 (7th Cir. 2003) (allowing asset acquirer to enforce employee trade secret agreement it did not specifically assume) and Campbell v. Millennium Ventures, LLC, 55 P.3d 429 (N.M. Ct. App. 2002) (the company's goodwill implicitly included employment agreements and noncompetition covenants).
[35] The rationale in the sale of business context for enforcing noncompetition covenants is to protect the goodwill of the company and prevent immediate competition when acquirers have paid valuable consideration for the business. See Jon-Mark C. Patterson & Joel M. Funk, Covenants Not to Compete in the Sale of a Business: Protecting Good Will, 26-Dec Colo. Law. 31, 32 (1997); see also Cal. Bus. & Prof. Code Ann. § 16601 (2004); see EarthWeb, Inc, 71 F. Supp. 2d at 306, 313 (recognizing the dynamic nature of Internet businesses).
[36] See 29 U.S.C. § 203 (2000); Rev. Rul. 87-41, 1987-1 C.B. 296 (1987) (twenty factor test for independent contractors).
[38] See Richard S. Rosenberg & Douglas N. Silverstein, Susceptible Startups, Los Angeles Daily J., Feb. 23, 2001, available at link. Blogs are short for web logs.
[40] Many individuals working at a start-up or Internet-based company are young and tech savvy, see id., which fits the estimated demographic for bloggers. See Perseus, The Blogging Iceberg (2003), available at link; Perseus, The Blogging Geyser (2005), available at link.
[42] Under Title VII of the Civil Rights Act of 1964, courts will impute this harassment to the employer in that they condoned a sexually objectionable environment. The plaintiff must demonstrate that the employer had notice of the harassment and failed to take both prompt and reasonable remedial action calculated to end the harassment. See Faragher v. City of Boca Raton, 524 U.S. 775 (1998).
[43] See, e.g., Marsh v. Delta Air Lines, Inc., 952 F. Supp. 1458 (D. Colo. 1997) (holding Colorado's prohibition against terminations based on an employee's lawful, off-duty activities did not prevent company from firing an employee because the employee's activities harmed the company's business reputation); Ellen Simonetti, I Was Fired for Blogging, ZDNet, Dec. 17, 2004, available at link (employee was fired because her blog harmed the reputation of her employer).
[44] Typically, foreign qualification requires a certificate of authority and the appointment of a resident agent on whom process may be served. See, e.g., Cal. Corp. Code § 2105 (West 2004); Colo. Rev. Stat. §§ 7-115-101 to 7-115-303 (2004); N.Y. Bus. Corp. Law §§ 1301-1306 (McKinney 2004); see generally CT Corp. Sys., What Constitutes Doing Business (2003).
[45] For example, if an Internet-based company located outside of Colorado conducts no business activities in the state (other than engaging in e-commerce by soliciting orders from Colorado residents through its Web site that require acceptance of the orders outside of the state), it would appear that under the relevant statutory provisions such a business would not be required to register as a foreign corporation. See Colo. Rev. Stat. § 7-115-101(2)(f) (2004).
[46] Depending on the state, the repercussions of failing to register can include monetary fines and penalties, invalidity of contracts, denial of access to courts, and personal liability for officers or directors of the corporation. See Ct Corp. Sys., supra note 44, at 7-26.
[47] For example, acquirers may be required to become qualified when they acquire the assets of a target company located in a foreign jurisdiction in which the acquirer had no prior business contacts or, as a result of such acquisition, the acquirer now has employees or leases space in such jurisdiction. See Ct Corp. Sys., supra note 44, at 67-69, 96-97.
[48] The single issue most heavily litigated by cyberspace companies has been whether, and to what extent, the business in question has subjected itself to the jurisdiction of the courts of a specific state as a result of its e-commerce activities. Julian S. Millstein et al., Doing Business on the Internet: Forms and Analysis §§ 4-40 to 4-44.3 (2000).
[49] See, e.g., Cal. Corp. Code § 201 (West 2004) (using "the same as, or resembles so closely as to tend to deceive"); Colo. Rev. Stat. § 7-90-601(2) (2004) (using "shall be distinguishable on the records of the secretary of state"); Del. Code Ann. tit. 8, § 102(a)(1) (2004) (using " shall be such as to distinguish it upon the records in the office of the Division of Corporations in the Department of State"); N.Y. Bus. Corp. Law § 301(a)(2)(i) (McKinney 2004) (using "such as to distinguish it from the names of corporations of any type or kind").
[50] Even if a "dot.com" company is able to qualify under its official corporate name, attorneys should advise the company that it nevertheless could incur liability to an existing business under common-law unfair competition, deceptive trade practice, or trademark and service mark infringement principles for using such name.
[51] For a general discussion of third-party legal opinions in the context of acquisitions, see Model APA Agreement, supra note 7, vol. 2, at 67-90; Model SPA Agreement, supra note 7, at 313-21; Tri-Bar Opinion Committee, Third Party "Closing" Opinions, 53 Bus. Law. 592 (1998), available at link.
[52] In most cases, it probably is more appropriate for M&A practitioners to opine only as to the jurisdictions in which the company is qualified as a foreign corporation, or to attempt to add the qualifier "except where the failure to be qualified would not have a material adverse affect on the target company." The TriBar Opinion Committee has suggested that the former approach is the preferable one in rendering a foreign qualification opinion, although it also has indicated that "the opinion process could be streamlined without any meaningful detriment to opinion recipients if absent special circumstances the practice of rendering foreign qualification and foreign good standing opinions were discontinued and opinion recipients were to rely directly on the certificates themselves." See Tri-Bar Opinion Committee, supra note 51, at 647.
Citation
6 U.C. Davis Bus. L.J. 6 (2005)
Copyright
Copr. © E. Lee Reichert, 2006. All Rights Reserved.
Navigating the Black Holes
Vol. 6
January 2006
Page
Introduction
The development of the Internet has dramatically reshaped the merger and acquisition ("M&A") landscape from both a business and legal standpoint. Much of the M&A activity over the past few years has involved companies that either operate exclusively in cyberspace or that rely on e-commerce as an important component of their business activities. In a number of cases, companies actively acquired the assets of failed dot-com businesses. More recently, acquirers, in many cases public companies, have targeted Internet companies that weathered and survived the downturn.
As with other new technologies, the development of the Internet has resulted in legal refinements in a variety of areas as the law struggles to catch up with the technology. While some laws and judicial decisions make no distinction between companies engaging in cyberspace activities and traditional bricks-and-mortar businesses, many other areas remain in a state of evolution because of new Internet-based business models. The expansion of the Internet and the corresponding legal developments have forced M&A practitioners to familiarize themselves with a number of new legal issues for transactions involving companies engaged in e-commerce activities.
As a result, M&A attorneys need to fully appreciate and understand Internet-related issues in order to properly advise and obtain adequate protection for their clients. There are several areas of concern for businesses acquiring companies with substantial cyberspace activities, such as taxation of e-commerce activities, which previously have received extensive focus from commentators.[1] Rather than revisit those issues, this article focuses on five different legal "black holes" on which there is little written guidance and/or the law is continuing to rapidly evolve. Specifically, this article addresses (i) securities law issues; (ii) intellectual property issues; (iii) restrictive covenants; (iv) employment law issues; and (v) foreign qualification issues, each in the context of acquiring a business engaged in ongoing cyberspace business activities.[2]
Securities Law Issues
A huge area of potential liability for Internet-based companies involves the prior issuance of securities. Because start-ups typically have limited financial resources, they often rely on stock options or warrants as vehicles to attract, retain, and reward initial employees and consultants. Employees like to receive incentive stock options because of the huge upside that can result from a business that rapidly increases in value and subsequently enjoys an exit event, whether it is an acquisition or an initial public offering ("IPO"). In many cases, however, companies establish the underlying equity incentive plans or issue securities without appropriate consultation with securities law counsel.
Perhaps the most noteworthy example of a company that failed to properly comply with state and federal securities laws is Google, Inc. While preparing for its IPO in 2004, Google disclosed in a filing with the Securities and Exchange Commission (the "SEC") that it failed to comply with federal and state blue-sky laws (in close to 20 states) in connection with the issuance of approximately 23 million shares of stock and 5.6 million stock options to over 1,000 current and former employees and consultants.[3] Securities regulators were concerned that Google distributed the options to employees as part of their compensation without providing adequate financial information about the company. Google conducted a rescission offering with respect to all of the improperly issued securities in which the company offered to buy back the affected shares and outstanding options for approximately $26 million. So as to not to delay or jeopardize its IPO, the company subsequently entered into a settlement with the SEC and state regulators in which Google agreed to cease and desist from committing or violating any provision of the securities laws.[4]
M&A practitioners involved in an acquisition of an Internet-based business-especially where the transaction is structured as a merger or a stock purchase-should focus during the due diligence process on the target company's adoption of equity incentive plans and the issuance of prior securities. Attorneys should pay particular attention to incentive stock options and warrants as well as any attempts by the target company to offer to sell securities over the Internet.
In addition to performing appropriate due diligence, acquirers should insist on representations and warranties in the acquisition agreement covering compliance with (i) state blue-sky and federal securities laws; and (ii) corporate requirements associated with the offering and issuance of the securities or adoption of plans, including preemptive rights and anti-dilution protections.[5] In addition, because the prior termination of employees who were granted options often can lead to claims following an exit event,[6] an acquirer may want to consider specific representations and warranties or special indemnification provisions with regard to such matters.[7] Finally, it may be appropriate for an acquirer to require the target company to conduct a rescission offering with regard to improper prior issuances of securities if significant issues are discovered during due diligence.[8]
Intellectual Property Issues
Another area where start-ups operating in cyberspace often take shortcuts that later can become significant issues in the acquisition process, if not outright deal-killers, relates to title and protection of intellectual property.
Obviously, a significant portion of the value of any Internet company resides in the intellectual property of the business, including the Web sites it owns or operates. Accordingly, acquirers must have a good understanding of all of the company's intellectual property rights and the potential liabilities associated with such assets.
To do so, acquirers and their attorneys must spend a significant portion of their due diligence validating the intellectual property from both the business and legal perspectives.[9] Standard due diligence checklists typically are written in such broad terms to pick up the relevant intellectual property assets and contracts. With the creation of new types of Internet-related agreements, licenses, and intellectual property assets, however, it is advisable for acquirers' attorneys to specifically tailor their due diligence checklists so as to better focus attention on the types of agreements[10] and other items[11] that the target company should disclose. In addition, as part of due diligence, acquirers should ensure that no liens or encumbrances exist on any of intellectual property rights. A standard Uniform Commercial Code ("UCC") search typically is only the starting point with regard to such intellectual property rights.
Along with conducting a proper due diligence inquiry, an acquirer should obtain representations and warranties in the acquisition agreement that:
· The target company has all right, title, and interest to the intellectual property it uses in its business activities.
· No intellectual property being acquired infringes on the intellectual property rights of any other party.
· All e-commerce activities and Web sites are operated and maintained in accordance with appropriate commercial practices and all laws and regulations.
Ownership or proper licensing of the underlying intellectual property is critical for a cyberspace company. As a result, the representations and warranties in the acquisition agreement should provide that (i) the target company owns or properly licenses all intellectual property; (ii) the target company can validly transfer all intellectual property rights; and (iii) no undisclosed party has retained any rights to any intellectual property being acquired. In some cases (particularly in the early stages for start-ups), the company may have allowed parties to web development agreements to retain certain rights to the "look and feel" or content of a Web site, which can create problems for an acquirer.[12]
With regard to infringement, in addition to obtaining a general and broad representation that no intellectual property being acquired infringes on the rights of any other party, the representations should provide that the target company has not received notice of any possible infringement actions, whether under the Digital Millennium Copyright Act or otherwise.[13] Acquirers also should consider whether their own technology, when combined with the target company's technology post-closing, may infringe on any other party's intellectual property rights.
The use of domain names has spawned a number of infringement lawsuits as well as administrative actions before the World Intellectual Property Organization and other organizations charged with dispute resolution by the Internet Corporation for the Assigned Names and Numbers ("ICANN") under its Uniform Domain-Name Dispute Resolution Policy. The use of a particular domain name by a company can result in liability claims under the Anti-Cybersquatting Consumer Protection Act,[14] the Lanham Act,[15] state law, or common-law trademark and service mark principles. Similarly, the use of a "meta-tag" (an embedded file that while not readily visible can be read and indexed by Internet search engines) within a Web site can infringe on the common-law or registered trademark or service mark rights of a third party.[16]
Depending on the specific nature of the company's Web sites, acquirers also should consider obtaining specific representations to provide additional liability protection with regard to possible infringement actions that: (i) the domain names for the target company's Web sites are not trademarks or service marks of any other companies; (ii) the target company has the right to link to other Web sites to which its Web sites are linked;[17] (iii) the target company has the appropriate rights to display all names, symbols, logos, trademarks and other intellectual property of any party that is located on its Web sites and does not display any trade secrets of any other party thereon; (iv) the target company's Web sites do not use meta-tags that infringe upon any other business's trademarks, service marks or other intellectual property rights; and (v) there are no actions pending before an ICANN-sanctioned arbitrator or otherwise.
Finally, acquirers should obtain specific representations and warranties with regard to compliance with customary commercial practices and applicable laws and regulations.[18] Acquirers should request warranties that all Web sites have appropriate protections in place to prevent unauthorized modification or alteration by third parties. To confirm its due diligence findings, acquirers may also require express representations and warranties as to the traffic on the relevant Web sites. As part of due diligence, acquirers may want to consider having an independent third party or tracking software verify a company's data, so as to ensure that the company does not artificially inflate the number of unique visitors or hits through their own visits to the Web site. In drafting and negotiating such contractual provisions, attorneys also should ensure that the measurement provisions are drafted precisely in order to obtain the most relevant information and confirm the underlying valuation metrics.[19]
Restrictive Covenant Issues
Following the company's IP rights, oftentimes the next most valuable intangible asset of an Internet-based business consists of the restrictive covenants or other agreements that the company's employees have executed. In many cases, these individuals are critical to the success of the Internet business venture and represent important intellectual capital.[20] The ongoing battle between the industry giants Microsoft and Google this year, over an employee's noncompetition covenant, perhaps best highlights the significance of these issues for high-tech companies.[21]
As part of the due diligence process, an acquirer should request copies of all confidentiality, nondisclosure, invention assignment agreements, and restrictive covenants (e.g., noncompetition and nonsolicitation covenants) executed by the company's employees and independent contractors. Oftentimes, these provisions appear in employment agreements of senior executives of the company. Attorneys for the acquirer then must determine (i) whether the acquirer likely will continue to enjoy the benefits of the agreements following the acquisition; and (ii) if so, whether the agreements likely will be enforceable under applicable state law.[22]
The enforceability of the noncompetion and nonsolicitation covenants used by companies to protect their investment in employees is a matter of state law, and while a few jurisdictions completely prohibit employee noncompetition covenants,[23] most states enforce agreements imposing reasonable restrictions on employees.[24] Although noncompetition law can vary dramatically among jurisdictions, generally for an employee noncompetition covenant to be enforceable, it must contain reasonable geographic and time limitations and be reasonably limited in the scope of prohibited activity.[25] Whether a nonsolicitation covenant constitutes a noncompetition covenant that must satisfy the same requirements also varies by state.[26]
As a result of the unique state law issues regarding employee restrictive covenants and their assignability, there is no guarantee that an acquirer still may enforce such agreements following an acquisition, particularly one structured as an asset purchase. Some jurisdictions provide that a company can never assign noncompetition covenants.[27] Other states permit an employer's successors or assigns to enforce noncompetition covenants so long as the original employment contract contains an express assignment clause.[28] Still other jurisdictions follow a rule that, absent a contrary provision in the agreement, a noncompetition covenant may be freely assigned and enforced by an assignee.[29]
In reviewing restrictive covenants to determine the likelihood of enforceability, M&A practitioners should realize that the traditional rules of interpretation might not apply to companies operating in cyberspace. Because of the rapidly changing nature of the technology and the ability of the Internet to reach any jurisdiction from any location, courts have shown a willingness to apply different rules to cyberspace employees with regard to the geographic, time, and prohibited activity limitations.
Recently, courts have been cognizant of the global reach of the Internet in construing geographic restrictions in employee noncompetition covenants.[30] While no published opinion has yet gone so far as to eliminate completely the geographic requirement for cyberspace companies as a matter of law, arguably the Internet has made geography irrelevant.[31] Similarly, with regard to time restrictions contained in cyberspace employee covenants, courts have suggested the acceptable period restriction is shorter because of the rapid speed at which the business of Internet-based companies and technologies change.[32] The fact that information loses its competitive value more quickly for cyberspace companies means that, at least in this instance, time does move more quickly in the Internet age. Finally, in reviewing limitations on prohibited activities in high-tech cases, courts have shown an inclination to ensure that these restrictions are consistent with, and limited to, the job previously performed by the employee.[33]
Nonsolicitation covenants also raise unique issues for cyberspace companies. To be enforceable, these clauses probably cannot prohibit solicitation of all customers, as often is the case with traditional businesses, because such a restriction presumably would apply to anyone who could access a company's Web sites. Cyberspace companies, however, still can restrict the ability of employees to directly solicit parties with whom the company has established business relationships and other employees of the company.
In reviewing restrictive covenants, attorneys for acquirers should review carefully each of the geographic, time, and activity restrictions in light of the company's current business as well as the proposed business of the acquirer. In addition, attorneys should determine whether the relevant agreements contain acknowledgements that (i) the company conducts Internet-based business activities; (ii) consumers are able to access the company's Web sites from any geographic location; (iii) the monetary barriers to establishing and engaging in a competitive business over the Internet are relatively small; and (iv) the geographic, time, and restricted activity limitations contained in the restrictive covenant are reasonable, given the foregoing considerations.
If an acquirer expects to obtain the benefit of restrictive covenants, confidentiality agreements, or similar agreements through assignment in an asset acquisition, the acquisition documents should specifically identify and assign these items.[34] To the extent an acquirer has concerns about the enforceability of the restrictive covenants, either due to assignment issues related to the structure of the deal, as a result of the manner in which the original covenants were drafted, or because of the relevant state's attitude towards these covenants, oftentimes the better approach for an acquirer is to ensure that the underlying parties to the relevant agreements expressly consent to their assignment or enter into new legally enforceable agreements with the acquirer.
Aside from employee restrictive covenants, M&A practitioners typically must deal with the negotiations related to new restrictive covenants from equity owners as part of the acquisition. In addition to the issues discussed above for employees, attorneys need to realize that at this point it is unclear whether courts will interpret the geographic and time restriction requirements for former equity owners of cyberspace companies more broadly in the "sale of business" context than in the "employment" area. This has been the typical approach for courts in cases involving non-Internet companies because of the different policy considerations involved in acquisitions and the employee-employer relationship. The logic behind the cyberspace employee cases discussed above, and recognition of the "dynamic nature" of the Internet, however, may apply with equal force in the sale of business arena.[35]
To provide additional protection from equity owners who are not being retained after the closing, acquirers should include a nondisclosure covenant with regard to all confidential and proprietary information being acquired as part of the acquisition as well as a nonsolicitation covenant. By placing the separate nondisclosure and nonsolicitation covenants in the acquisition agreement itself, an acquirer may increase the likelihood of enforceability by preventing a court from confusing these provisions with a noncompetition covenant, which is typically contained in the separately executed agreement.
In many cases, however, the former equity owners of the target company will continue to act as employees or consultants for the acquirer following the closing because they are a critical component of the value of the acquired cyberspace business. In addition to the documents executed as part of the consideration for the acquisition at the closing, acquirers should take the same precautions they take with their other employees and have such parties execute the acquirer's standard-form confidentiality, nondisclosure, nonsolicitation, and noncompetition agreements.
Employment Law Issues
As noted above, acquirers of cyberspace companies frequently wish to maintain relationships with the target company's employees, including its former equity owners, as well as its independent contractors. As a result, it is important for M&A practitioners to focus on liability issues that can arise with respect to such parties both in due diligence and the acquisition agreement.
A number of Internet start-ups attempt to avoid paying overtime, payroll taxes, workers' compensation insurance, and other benefits by hiring independent contractors instead of employees. Under the Fair Labor Standards Act and the Internal Revenue Service guidelines, only if parties truly are independent (e.g., exercise control over their own work) do they qualify as independent contractors.[36] As a result, substantial exposure for wages and employment taxes can exist to the extent a company has improperly classified individuals as independent contractors, whether deliberately or inadvertently.
Another area where Internet ventures particularly are prone to significant financial and legal exposure relates to overtime laws. The expectation at many start-ups is that employees will work long hours to get the business off the ground. In addition to the incentive stock options described above, these companies often pay salaries to all of their employees to avoid paying any overtime for the long hours put in by employees. In most cases, however, the business never investigates whether these employees are in fact exempt from overtime requirements in the first instance.
M&A practitioners need to review carefully the relevant statutes and underlying regulations issued by the Department of Labor ("DOL"), particularly for computer-related occupations in evaluating whether employees of cyberspace companies are exempt from overtime requirements. Under these regulations, while many computer programmers may not be exempt from the overtime requirements, some software designers may be exempt.[37]
Incorrect classification of a group of employees can lead to a subsequent action (particularly after the announcement of an exit event) on behalf of all similarly situated employees by disgruntled former employees, the DOL, or analogous state regulatory agencies. As such, in addition to specific representations and warranties regarding compliance with overtime laws, acquirers may desire to obtain special indemnification in the acquisition agreement for such potential liabilities, which can include substantial penalties such as the doubling of damages to aggrieved employees.
Cyberspace companies also have a higher risk profile for sexual harassment and inappropriate blogging claims.[38] The combination of relaxed dress policies, relative youthful age of the workforce, more informal work atmosphere, and long work hours often combine to create a work environment more susceptible to questionable behavior.[39] Inappropriate, careless, or offensive communications contained in blogs or emails can also create liability for a company.
Blogs raise significant concerns for acquirers of Internet-based companies. Employees working at Internet-based and start-up companies fit the demographic for the typical blogger.[40] While individuals generally discuss politics and interests on blogs, they also can delve into their work environment, coworkers, and bosses. As such, bloggers can inadvertently cause their employers and acquirers significant legal hardship. For example, a blogger could (i) disclose confidential information and trade secrets;[41] (ii) engage in gun-jumping or trigger other securities law violations; (iii) post copyrighted music or other items on their blog during company hours; (iv) engage in sexually or other harassing behavior;[42] or (v) harm their company's business reputation by complaining about company policies or the work environment.[43] As part of the due diligence inquiry, acquirers therefore should request copies of the company's policies regarding (i) blogging, (ii) e-mail retention and destruction, (iii) e-mail and web usage, and (iv) e-mail monitoring.
Foreign Qualification Issues
A final and often overlooked area of potential liability for cyberspace companies relates to foreign qualification. When a company engages in business outside of the state in which it is incorporated or organized, it may be required to obtain a "foreign qualification" from the other jurisdictions in which it operates.[44] Whether a company must qualify in a foreign jurisdiction depends on whether it is "doing business" in that jurisdiction under the applicable foreign qualification statutes, as that state's courts or regulatory agencies have interpreted such statutory provisions.
As most M&A practitioners realize, determining whether a traditional business with no Internet presence has received all necessary foreign qualifications is often difficult because it involves a facts-and-circumstances analysis of the activities the company engages in and requires a review of different laws in various jurisdictions. Obviously, the foreign qualification issue is more difficult when analyzing cyberspace companies due to the evolving questions regarding jurisdiction and local governmental authority over Internet activities.[45]
Failing to obtain foreign qualifications can be significant in some jurisdictions.[46] This issue arises if an acquisition is structured as (i) a merger or stock transaction, where the acquirer can have liability based on the target company's prior operation of the business; or (ii) as an asset purchase, where the acquirer can have exposure for its own operation of the business after the acquisition. In the latter case, attorneys for acquirers need to determine whether, because of an acquisition, their client now needs to qualify to do business in a foreign jurisdiction where it previously was not required to be qualified.[47] The implications of a foreign qualification on future business activities can also be significant as a party may subject itself unintentionally to jurisdiction for tax or other purposes.[48] Because of these foregoing considerations, M&A practitioners should focus carefully on this issue in transactions involving companies with Internet activities.
Another area of foreign qualification potential liability involves companies that use ".com" as part of their corporate name. Before the proliferation of domain names endings other than ".com," it was quite common for companies to register a domain name to enjoy the cachet of being a "Dot-com Company." For companies that chose such a name, many issues can exist due to foreign qualification statutory provisions.
Most foreign qualification statutes contain a provision that requires a company's corporate name either to be "not deceptively similar to" or "distinguishable on the records of the secretary of state from" other businesses already established as a domestic entity or qualified as a foreign business entity in such state.[49] For example, regulatory authorities in some states may take the position that merely adding ".com" (or for that matter ".org" or ".net") to the end of the corporate name "ACME" is not sufficiently different to permit foreign qualification under the name "ACME.com, Inc." where an "ACME, LLC" or "ACME, Inc." already exists in the jurisdiction.[50] Correspondingly, even if "ACME.com, Inc." is able to obtain a foreign qualification under its official corporate name, there may be no prohibition under the jurisdiction's statutes to prevent an "ACME, LLC" or "ACME, Inc." from subsequently being organized or qualifying as a foreign corporation in the state.
Finally, M&A practitioners should be aware of the foregoing foreign qualification issues in rendering third-party legal opinions on behalf of a client with substantial cyberspace activities. Such third-party legal opinions are often a condition to closing for acquisitions.[51] In many cases, M&A practitioners are requested to opine that their clients are duly qualified in all states in which the nature of their client's business makes such qualification necessary. Based on the discussion above, attorneys representing cyberspace companies should consider carefully the type of opinion they are prepared to give on the status of their client's foreign qualification.[52]
Conclusion
Acquisitions of companies engaged in substantial e-commerce activities are more complex than other transactions because of the start-up nature of these ventures and their penchant for being early adopters of new technologies. To be effective in this area, M&A practitioners need to understand the unique issues and latest legal developments as they affect cyberspace companies. By understanding the difficult "black holes" that exist with regard to cyberspace companies, attorneys can either steer their clients away from trouble or at least use traditional tools - whether specific representations and warranties, elimination of knowledge and materiality qualifiers, carve-outs from baskets or caps, special indemnification provisions, or earn-out provisions - to navigate through these issues and obtain adequate deal and liability protection for their clients.[53]
[1] See generally Nathaniel T. Trelease & Lea Anne Sotrum, The Gathering Storm: State Sales and Use Taxation of Electronic Commerce, 30 Corp. Tax'n 16 (2003); Arthur J. Cockfield, Balancing National Interests in the Taxation of Electronic Commerce Business Profits, 74 Tul. L. Rev. 133 (1999); Val John Christensen, Leveling the Playing Field: A Business Perspective on Taxing E-Commerce, 2000 BYU L. Rev. 139.
[2] See generally Roland L. Trope & Gregory E. Upchurch, Checkpoints in Cyberspace: Best Practices to Avert Liability in Cross-Border Transactions (forthcoming Feb. 2006).
[3] Google, Inc, Form S-1 Registration Statement Under the Securities Act of 1933 (Aug. 4, 2004), available at link [hereinafter Google Filing].
[4] In re Google, Inc. & David C. Drummond, Securities Act Release No. 33-8523, Admin. Proc. File No. 3-11795 (Jan. 13, 2005), available at link.
[5] See 17 C.F.R. § 230.701 (2004) (contains Federal Rule 701 regarding stock options). See generally Howard M. Friedman, Securities Regulation in Cyberspace (3d ed. 2005).
[6] The practice of granting incentive stock options to employees in lieu of a higher base salary or bonus can create potential liability in the context of an exit event. Employees who are terminated prior to the vesting of their incentive stock options are more likely to bring a wrongful termination lawsuit when the company has undergone rapid growth and the options are worth a significant amount as a result of the exit event. See Scully v. US WATS, Inc., 238 F.3d 497 (3d Cir. 2001) (holding that a telecommunication carrier breached an oral agreement with its president when it fired him without cause and denied him the opportunity to exercise his stock options).
[7] Acquirers may want to consider a specific representation and warranty that a target company has no reason to believe any such claims exist, including any notice of such claims, as well as provisions in the indemnification section providing for carve-outs for such claims from any baskets or caps. See generally Lou R. Kling & Eileen Nugent, Negotiated Acquisitions of Companies, Subsidiaries and Divisions (1992); Bus. L. Sec., Am. Bar Ass'n, Model Asset Purchase Agreement with Commentary (2001) [hereinafter Model APA Agreement]; Bus. L. Sec., Am. Bar Ass'n, Model Stock Purchase Agreement with Commentary (1995) [hereinafter Model SPA Agreement].
[8] A recission offering is not without risk, as parties may elect to reject the recission offer and instead sue the issuer for securities law violations. See, e.g., Google Filing, supra note 3.
[9] David E. Swarts, Buying a Dot-com, 10 Apr. Bus. L. Today 16, 19 (2001), available at link. While the Internet has created new issues for M&A practitioners performing due diligence, it also has made due diligence on cyberspace companies easier in certain respects. Because the Web sites of a cyberspace company frequently include information about the company as well as its operations and business partners, these Web sites can provide useful information to the lawyers performing due diligence and allow for more focused requests and inquiry.
[10] For example, attorneys for acquirers should add the following agreements to their due diligence checklists: (i) Web marketing, co-branding licensing and advertising agreements; (ii) Web-linking or framing agreements with other Web sites; (iii) Web hosting agreements; (iv) Web development and design agreements; (v) Web content creation, licensing and access agreements; (vi) affiliate, strategic alliance, and joint venture agreements; (vii) placement agreements with search engines, (viii) software development and license agreements; (ix) maintenance agreements and warranties for servers; (x) source code escrow agreements; and (xi) any electronic contracts. Id. at 18; see also Gary M. Lawrence & Carl Baranowski, Representing High Tech Companies §§ 6-1 to 6-62 (1999).
[11] In addition to the normal requests for all intellectual property (including any trademarks, service marks, copyrights, trade names, etc.), attorneys for acquirers of cyberspace companies should request the following information: (i) a list of all Web sites and domain names, or applications or reservations for either; (ii) all current and prior privacy policies, terms and conditions of use and disclaimers posted on any Web sites to be acquired; (iii) descriptions of Internet firewalls; (iv) description of policies and procedures to monitor other e-commerce companies' use of the target company's intellectual property; and (v) copies of reports documenting traffic on all relevant Web sites. Swarts, supra note 9, at 19.
[12] To the extent that a cyberspace company has used consultants or independent contractors (as opposed to employees) to create intellectual property, acquirers should ensure that any work product created by such persons contractually has been treated as "work-for-hire" or otherwise properly assigned to the company. Generally, an employee is obligated to assign patent rights to an employer (i) if there is an express provision in the contract requiring such assignment; (ii) the employee was specifically hired to invent; or (iii) the employee is an officer of the corporation with the fiduciary obligation to act in good faith and in a manner reasonably related to the best interests of the corporation and its shareholders. See, e.g., Lacy v. Rotating Prods. Sys., Inc., 961 P.2d 1144 (Colo. Ct. App. 1998). If, however, the employment relationship does not entail one of these three factors, then an employee is under no obligation to assign the patent to his employer although the employee probably will have to grant his employer "shop rights" or a free and non-exclusive right to practice the patent if the employee used company resources to invent the patent. See, e.g., Scott Sys., Inc. v. Scott, 996 P.2d 775 (Colo. Ct. App. 2000).
[14] Anticybersquatting Consumer Protection Act, 15 U.S.C. § 1129 (1999). The Anti-Cybersquatting Consumer Protection Act makes it illegal for a person to "register, traffic in, or use" a domain name of another person if the domain name is a trademark (or confusingly similar to the trademark) of another person, and the person who registers, traffics in, or uses the domain name has a "bad faith intent to profit" from that trademark. Id.
[16] See Playboy Enters., Inc. v. Calvin Designer Label, 985 F. Supp. 1220 (N.D. Cal. 1997) (determining that the hidden use of the words "Playboy" and "Playmate" constituted trademark infringement).
[17] Similarly, if information is framed from other Web sites, a company should have approval from the party whose information is being framed. See generally Cyberspace Law Committee, Bus. L. Sec., Am. Bar Ass'n, Web Linking Agreements: Contracting Strategies and Model Provisions 24-25 (1997) (hereafter Web Linking Agreements).
[18] Depending on where a company does business, state-specific laws may apply. See, e.g., Cal. Bus. & Prof. Code § 17538 (2004) (requiring retail companies that accept orders from California residents to comply with certain provisions); S.B. 1386, 2002 Cal. Stat. 915 (amending Cal. Civ. Code §§ 1798.82, 1798.29) (protects California consumers by requiring businesses to disclose to California' consumers any breaches in computer security that could compromise their personal information).
[19] The appropriate method of traffic measurement for a Web site may be described in a number of ways, such as "eyeball return rate," "unique visitors," or "hits." See generally Web Linking Agreements, supra note 17. An "eyeball return rate" measures the number of times a Web page is requested, while "unique visitors" refer to all unique e-mail addresses that visit a Web page. On the other hand, a "hit" technically refers to a single request for a file. Requesting a single page may involve calling up several different files, which would register several hits for a single visit, which may or may not be the relevant measurement of traffic. Differences in the tracking criteria can substantially affect the underlying value methodology. Swarts, supra note 9, at 19.
[20] See Katherine J. Clayton, Liquidating a Technology Company in Bankruptcy, 4 N.C. J. L. & Tech. 169, 179 (2002); Lois R. Lupica, The Technology Rich "Dot-Com" in Bankruptcy: The Debtor as Owner of Intellectual Property, 53 Me. L. Rev. 361, 381 (2001).
[21] Microsoft v. Lee, No. 05-2-23561-6 SEA (Wash. Super. Ct. Sept. 13, 2005); Allison Linn, Microsoft, Google Reach Settlement, Rocky Mountain News (December 23, 2005), available at link
[22] While M&A practitioners should check all agreements to determine whether the proposed structure of the acquisition will trigger notice or consent requirements under assignment or "change in control" provisions as in any due diligence review, it is particularly important to review these provisions in the employee-related agreements for cyberspace companies. See generally Model APA Agreement, supra note 7, at 64-67; see generally Annotation, Enforceability, By Purchaser of Successor of Business, of Covenant Not to Compete Entered into By Predecessor and Its Employees, 12 A.L.R. 5th 847 (1993).
[24] In many states, noncompetition covenants are expressly permitted for the protection of trade secrets. See, e.g., Colo. Rev. Stat. § 8-2-113(2) (2004). In addition, many states authorize such covenants for executive and management personnel and officers, which in some cases do not apply to independent contractors. Id.; see also Smith v. Sellers, 747 P.2d 15 (Colo. Ct. App. 1990).
[25] In some jurisdictions that allow reasonable noncompetition agreements, court strike down the entire covenant if one provision is overbroad. Other courts will "blue pencil" a covenant and enforce the reasonable restrictions while invalidating the overly broad provisions. See, e.g., DoubleClick, Inc. v. Henderson, No. 116914/97, 1997 WL 731413 (N.Y. Sup. Ct. Nov. 7, 1997) (reducing time limitation under New York law from one year to six months).
[26] Courts have split on whether nondisclosure and nonsolicitation covenants must contain geographic and time restrictions. See Lawrence & Baranowski, supra note 10, at §§ 3-12 to 3-13; Atmel Corp. v. Vitesse Semiconductor Corp., 30 P.3d 789 (Colo. Ct. App. 2001) (finding that nonsolicitation covenants must satisfy provisions applicable to noncompetition covenants).
[27] See, e.g., Reynolds & Reynolds v. Hardee, 932 F. Supp. 149 (E.D. Va. 1996), aff'd, 133 F.3d 916 (4th Cir. 1997) (noncompetition covenants never are assignable when contained in employment agreement).
[28] See Hess v. Gebhard & Co. Inc., 808 A.2d 912, 921 (Pa. 2002); Saliterman v. Finney, 361 N.W.2d 175 (Minn. Ct. App. 1985). In All Pak, Inc. v. Johnston, 694 A.2d 347, 351 (Pa. Sup. Ct. 1997), the court noted that "[g]iven that restrictive covenants have been held to impose a restraint on an employee's right to earn a livelihood, they should be construed narrowly; and absent an explicit assignability provision, courts should be hesitant to read one into the contract."
[29] See, e.g., Special Products Mfg., Inc. v. Douglass, 553 N.Y.S.2d 506 (N.Y. App. Div. 1990) (holding that a restrictive covenant was enforceable by a successor because noncompetition covenants are freely assignable unless defeated by a clear and unambiguous contractual prohibition); Gill v. Poe & Brown of Georgia, Inc., 524 S.E.2d 328 (Ga. Ct. App. 1999) (nonsolicitation agreement could be assigned by employer to company, without employee's consent because the non-solicitation agreement did not prohibit unilateral assignments).
[30] See Nat'l Bus. Servs., Inc. v. Wright, 2 F. Supp. 2d 701, 708 (E.D. Pa. 1998) (enforcing restriction under Pennsylvania law and noting that "[t]ransactions involving the Internet, unlike traditional sales territory cases, are not limited by state boundaries"); Intelus Corp. v. Barton, 7 F. Supp. 2d 635 (D. Md. 1998) (upholding restriction under Maryland law with no geographic restriction for computer software company and product specialist).
[31] By its very nature, the Internet contains no geographic boundaries and a company can set up a Web site that may be accessed from anywhere in the world. Some courts in the future may take the position that to satisfy the geographic restriction, a noncompetition covenant for an employee of a company that operates solely over the Internet only may prohibit a party from Internet activities (i.e., the covenant expressly should allow the restricted party to operate a competitive traditional bricks-and-mortar business). In such a case, a number of areas would remain in which the restricted party could compete in the same general business as the Internet company, just not through the same medium.
[32] See EarthWeb, Inc. v. Schlack, 71 F. Supp. 2d 299, 316 (S.D.N.Y. 1999), aff'd in part, 205 F.3d 1322 (2d Cir. 2000) (refusing to enforce a one-year noncompetition covenant under New York law because "[w]hen measured against the IT industry in the Internet environment, a one-year hiatus from the workforce is several generations, if not an eternity."); see also DoubleClick, Inc. v. Henderson, No. 116914/97, 1997 WL 731413 (N.Y. Sup. Ct. Nov. 7, 1997) (reducing time limitation under New York law from one year to six months).
[33] See Marshall v. Gore, 506 So.2d 91 (1987) (holding under Florida law that the scope of a noncompetition restriction for an employee that developed software for feeding cows was overly broad to the extent it applied to software development generally).
[34] Compare McGladrey & Pullen, LLP v. Shrader, 62 Va. Cir. 401 (Va. Cir. Ct. 2003) (because asset purchase agreement specifically assigned the employment contracts but made no mention of confidentiality and non-solicitation agreements, the assignee could not enforce these agreements) with Chemetall GMBH v. ZR Energy, Inc., 320 F.3d 714 (7th Cir. 2003) (allowing asset acquirer to enforce employee trade secret agreement it did not specifically assume) and Campbell v. Millennium Ventures, LLC, 55 P.3d 429 (N.M. Ct. App. 2002) (the company's goodwill implicitly included employment agreements and noncompetition covenants).
[35] The rationale in the sale of business context for enforcing noncompetition covenants is to protect the goodwill of the company and prevent immediate competition when acquirers have paid valuable consideration for the business. See Jon-Mark C. Patterson & Joel M. Funk, Covenants Not to Compete in the Sale of a Business: Protecting Good Will, 26-Dec Colo. Law. 31, 32 (1997); see also Cal. Bus. & Prof. Code Ann. § 16601 (2004); see EarthWeb, Inc, 71 F. Supp. 2d at 306, 313 (recognizing the dynamic nature of Internet businesses).
[36] See 29 U.S.C. § 203 (2000); Rev. Rul. 87-41, 1987-1 C.B. 296 (1987) (twenty factor test for independent contractors).
[38] See Richard S. Rosenberg & Douglas N. Silverstein, Susceptible Startups, Los Angeles Daily J., Feb. 23, 2001, available at link. Blogs are short for web logs.
[40] Many individuals working at a start-up or Internet-based company are young and tech savvy, see id., which fits the estimated demographic for bloggers. See Perseus, The Blogging Iceberg (2003), available at link; Perseus, The Blogging Geyser (2005), available at link.
[42] Under Title VII of the Civil Rights Act of 1964, courts will impute this harassment to the employer in that they condoned a sexually objectionable environment. The plaintiff must demonstrate that the employer had notice of the harassment and failed to take both prompt and reasonable remedial action calculated to end the harassment. See Faragher v. City of Boca Raton, 524 U.S. 775 (1998).
[43] See, e.g., Marsh v. Delta Air Lines, Inc., 952 F. Supp. 1458 (D. Colo. 1997) (holding Colorado's prohibition against terminations based on an employee's lawful, off-duty activities did not prevent company from firing an employee because the employee's activities harmed the company's business reputation); Ellen Simonetti, I Was Fired for Blogging, ZDNet, Dec. 17, 2004, available at link (employee was fired because her blog harmed the reputation of her employer).
[44] Typically, foreign qualification requires a certificate of authority and the appointment of a resident agent on whom process may be served. See, e.g., Cal. Corp. Code § 2105 (West 2004); Colo. Rev. Stat. §§ 7-115-101 to 7-115-303 (2004); N.Y. Bus. Corp. Law §§ 1301-1306 (McKinney 2004); see generally CT Corp. Sys., What Constitutes Doing Business (2003).
[45] For example, if an Internet-based company located outside of Colorado conducts no business activities in the state (other than engaging in e-commerce by soliciting orders from Colorado residents through its Web site that require acceptance of the orders outside of the state), it would appear that under the relevant statutory provisions such a business would not be required to register as a foreign corporation. See Colo. Rev. Stat. § 7-115-101(2)(f) (2004).
[46] Depending on the state, the repercussions of failing to register can include monetary fines and penalties, invalidity of contracts, denial of access to courts, and personal liability for officers or directors of the corporation. See Ct Corp. Sys., supra note 44, at 7-26.
[47] For example, acquirers may be required to become qualified when they acquire the assets of a target company located in a foreign jurisdiction in which the acquirer had no prior business contacts or, as a result of such acquisition, the acquirer now has employees or leases space in such jurisdiction. See Ct Corp. Sys., supra note 44, at 67-69, 96-97.
[48] The single issue most heavily litigated by cyberspace companies has been whether, and to what extent, the business in question has subjected itself to the jurisdiction of the courts of a specific state as a result of its e-commerce activities. Julian S. Millstein et al., Doing Business on the Internet: Forms and Analysis §§ 4-40 to 4-44.3 (2000).
[49] See, e.g., Cal. Corp. Code § 201 (West 2004) (using "the same as, or resembles so closely as to tend to deceive"); Colo. Rev. Stat. § 7-90-601(2) (2004) (using "shall be distinguishable on the records of the secretary of state"); Del. Code Ann. tit. 8, § 102(a)(1) (2004) (using " shall be such as to distinguish it upon the records in the office of the Division of Corporations in the Department of State"); N.Y. Bus. Corp. Law § 301(a)(2)(i) (McKinney 2004) (using "such as to distinguish it from the names of corporations of any type or kind").
[50] Even if a "dot.com" company is able to qualify under its official corporate name, attorneys should advise the company that it nevertheless could incur liability to an existing business under common-law unfair competition, deceptive trade practice, or trademark and service mark infringement principles for using such name.
[51] For a general discussion of third-party legal opinions in the context of acquisitions, see Model APA Agreement, supra note 7, vol. 2, at 67-90; Model SPA Agreement, supra note 7, at 313-21; Tri-Bar Opinion Committee, Third Party "Closing" Opinions, 53 Bus. Law. 592 (1998), available at link.
[52] In most cases, it probably is more appropriate for M&A practitioners to opine only as to the jurisdictions in which the company is qualified as a foreign corporation, or to attempt to add the qualifier "except where the failure to be qualified would not have a material adverse affect on the target company." The TriBar Opinion Committee has suggested that the former approach is the preferable one in rendering a foreign qualification opinion, although it also has indicated that "the opinion process could be streamlined without any meaningful detriment to opinion recipients if absent special circumstances the practice of rendering foreign qualification and foreign good standing opinions were discontinued and opinion recipients were to rely directly on the certificates themselves." See Tri-Bar Opinion Committee, supra note 51, at 647.
Citation
6 U.C. Davis Bus. L.J. 6 (2005)
Copyright
Copr. © E. Lee Reichert, 2006. All Rights Reserved.